Apple Added Another Digit

(Bloomberg Opinion) -- You know what’s cool? A trillion dollars.

I don’t have anything interesting to say about the fact that Apple Inc.’s equity market capitalization reached a trillion dollars yesterday, but both Bloomberg and the New York Times have interactive online features about what numbers you could add to get to a trillion, and Bloomberg’s even includes some numbers you could multiply or subtract to get to a trillion, so perhaps I should list some numbers you could divide to get a trillion? Like, if you had a mole of  dollars, and you divided those dollars evenly among all of the stars in our galaxy, each star would have about as many dollars as Apple’s market cap. Or if you expressed Warren Buffett’s net worth in Mexican pesos, that would be approximately Apple’s market cap expressed in pounds sterling. Or if you had a googol of dollars and you divided them by the number of atoms in the universe, you’d have about enough dollars to give an Apple market cap to each person on earth. And then we’d all be rich.

What does it mean that Apple is worth a trillion dollars? I think there are two possibilities:

  1. The consensus expected future cash flows to Apple shareholders have a present value of $1 trillion; or
  2. Other.

You should not completely neglect “other.” There is something self-referential about corporate valuations, and I do not think it is ridiculous to believe some version of the idea that a company is worth a trillion dollars because it is worth a trillion dollars, and not because shareholders have a rational model of the expected future cash flows and those flows happen to add up to a trillion dollars. 

But the more conventional explanation is that people are willing to buy Apple shares at a $1 trillion valuation because they expect Apple to give shareholders back more than $1 trillion in the future. (Really, a present value of more than $1 trillion in the future, which means roughly $1 trillion very soon or much more than $1 trillion much later.) That is, not to belabor it too much, a lot of money. Usually when a company is worth $X, that can mean that it is currently generating lots of cash and paying it out to shareholders and that cash is expected to add up to about $X, or that it is currently generating no cash at all and investing shareholder money in long-term projects, but that if all goes well and those projects pay off then it will in some distant future be able to pay out, like, $3X to shareholders. But as X gets really really really really big, then getting hypothetically even bigger in the future recedes as an explanation, and actually paying out cash in the present becomes more likely to dominate. 

And so in fact Apple has in the past few years initiated a dividend and a share buyback program, and has paid out a total of about $280 billion to shareholders. On the other hand there are few signs that investors treat it as a huge growth opportunity:

Comparatively speaking, its earnings don’t get anywhere near the respect of its megacap brethren. At $56 billion, profits in the past year are double the next biggest earner in the Nasdaq 100 Index. But its price-earnings ratio trails 70 percent of the gauge’s members.

Put it this way. If Apple’s income was treated with the same generosity bestowed on companies like Alphabet Inc. and Facebook Inc., its value would be closer to two trillion than just one.

The reasons it isn’t are well known. Apple’s bread and butter is hardware, unlike Google and Microsoft. And while nothing to sneeze at, its profit growth is running at about half the rate of Amazon. Creeping pressure on margins has raised concern about how booming future profits will be.

And my Bloomberg Opinion colleague Shira Ovide notes that Apple’s profit margins are shrinking as it spends more money on research and development. In some ways this is the opposite of the intuitive popular story of Apple, which is that it used its brilliance to invent superior products that it could sell at huge margins. I mean, that story is true: It did do that. (Cheaply: “Steve Jobs once said that ‘innovation has nothing to do with how many R&D dollars you have,’” Ovide notes.) But at some point, once you have invented the iPhone, you can simultaneously make a lot of money selling iPhones, and spend a lot of money trying to invent the next iPhone, and not invent the next iPhone.

In 1997, Michael Dell famously said that Apple should “shut it down and give the money back to the shareholders.” Apple’s market cap was about $2.8 billion at the time, and it closed at about $1,001.7 billion yesterday, so that strategy would have left about $999 billion on the table and is high on the list of worst financial ideas of all time. But in the long run it, or something like it, is the right idea for almost all companies. You take money from shareholders, you use it to make some things, you sell the things, you make a profit, you reinvest the profit in making new things, you repeat for as long as that makes sense, and eventually you either run out of things to make, or—if things go very very well indeed—you have more profits than you can possibly invest in making those things. In the very long run, the way to reward the shareholders for giving you money in the first place is to (1) make as much money as possible with their money and then (2) give most of it back to them. The difficulty is in the details, and the timing. You want to return money to shareholders after you’ve invented the iPhone, not 20 years before

CBS.

I wrote yesterday morning that “sexual-harassment diligence is on its way to becoming a routine part of M&A due diligence.” And then yesterday afternoon CBS Corp. had its earnings call, led by Chief Executive Officer Les Moonves, days after a giant New Yorker story by Ronan Farrow about allegations of sexual misconduct against Moonves. And, somewhat embarrassingly, nobody asked about those allegations. The word “elephant” is popular. “The elephant in the room went unmentioned,” is the first sentence of this Wall Street Journal article. “Not one analyst asked Moonves or the rest of the management team to address the elephant on the call,” wrote my Bloomberg Opinion colleague Tara Lachapelle. “CBS Ignores Ronan Farrow-Shaped Elephant in the Room on Earnings Call,” wrote Bess Levin. The Journal notes:

On Twitter, reporters and other observers mocked what they said was the cowardice ofthe analysts for failing to ask about the scandal.

One analyst, Rich Greenfield of BTIG Research, said on Twitter, “Shame on the CBS analysts who were allowed to ask questions and failed to use the opportunity.”

I don’t know. Presumably the analysts didn’t ask because they didn’t think they’d get a useful answer, which was a reasonable assumption given that (1) Moonves was the one running the call and (2) CBS began the call by saying those questions would be off limits. The function of a stock analyst is not primarily journalistic. If a reporter asks a public figure a question that he doesn’t want to answer, and he sputters and refuses to answer, then that has value: The public has learned something, even without an actual answer to the question. The comfortable have been afflicted. If an analyst asks a company a question that it doesn’t want to answer, and the company doesn’t answer, then he’s wasted a question; there’s no field in his financial model for “angry CEO sputtering.” And in any case the analyst’s job is as much about maintaining access to management—to update his own models and also to help his clients get access—as it is about asking penetrating questions. Losing favor with management, without getting your questions answered, seems like a strictly negative outcome. 

This is not to say that the sexual misconduct scandal is irrelevant to the financial model! Quite the opposite: In general, if a scandal might bring down a long-serving powerful CEO, that is going to be material to a company’s results, but it’s particularly important here because Moonves and CBS’s board are  fighting a very strange battle against CBS’s controlling shareholder. Anything that weakens Moonves’s position—whether it’s financial results, legal arguments in that fight, or an a personal scandal—matters in that fight, and might affect CBS’s future. It’s just that asking Moonves about it, in public, on an earnings call, is probably not the way to find out. 

Elsewhere, nobody asked about Carl Icahn’s activist position on the Cigna Corp. earnings call yesterday, either.

Oops.

The average annualized daily volatility of Bitcoin against the U.S. dollar, over the past year, is about 90 percent. That implies, loosely speaking, that about one day out of every 20, Bitcoin will move by more than about 11 percent against the dollar. In fact, Bitcoin has had daily moves of 10 percent or more on 22 days over the last 12 months, including 10 so far in 2018; seven of the 10 big moves in 2018 have been down 10 percent or more.

OKEx is a Hong Kong-based exchange that lists Bitcoin futures and allows 20x leverage. Leverage of 20x means that for every $1 you put up as margin at the exchange, you can buy $20 worth of Bitcoin futures. If the price of Bitcoin goes up by 5 percent, then those futures will be worth $21, and you will make $1 on your $1 investment. If the price of Bitcoin goes down by 5 percent, then those futures will be worth $19, and you will lose your whole dollar. If the price of Bitcoin falls by 10 percent in a day, which, again, has happened on average once a month this year, then those futures will be worth $18, and you will lose your whole dollar, and also there will be a dollar missing. Like, you were supposed to pay $2 to the person who sold you the futures, but you only put $1 into the exchange. Someone has to come up with the other dollar.

A massive wrong-way bet on Bitcoin left an unidentified futures trader unable to cover their losses, burning counterparties and threatening to dent confidence in one of the world’s largest cryptocurrency venues.

The long position in Bitcoin futures listed on OKEx, a Hong Kong-based exchange, had a notional value of about $416 million, according to an OKEx statement on Friday and data compiled by Bloomberg. While OKEx moved to liquidate the position on Tuesday, the exchange was unable to cover the trader’s shortfall as Bitcoin’s price slumped. Because OKEx has a “socialized clawback” policy for such instances, it will force futures traders with unrealized gains this week to give up about 18 percent of their profits.

“It’s a weird mechanism,” says a crypto trader who used to work at Morgan Stanley, in a significant understatement. OKEx “requires traders to pass a quiz on its rules before they can begin investing in futures,” which you can try here, and there is forced liquidation if you get too close to wiping out your margin, but … there are simpler and more effective ways to make sure that this doesn’t happen? Like Cboe and CME Group list Bitcoin futures contracts, and they require 40 percent and 43 percent maintenance margin, respectively. That’s leverage of a bit more than 2x. If Bitcoin prices fall by 40 percent in a day, then your margin will be wiped out and Cboe and CME will have a problem. But that never actually happens. The margin is set high enough that it’s not at too much risk of being wiped out in a day.

At OKEx … ????? The margin is set low enough that it’s at risk of being wiped out all the time, and when it is, they take money from everyone else on the exchange to make up for it. “It’s a weird mechanism”! I suppose the point is that if you want to gamble on Bitcoin, you want to gamble on Bitcoin, and just buying two Bitcoins for the price of one isn’t exciting enough for you; you want to lever up 20 times, while also gambling a bit that your winnings might be taken away from you. 

Or maybe not? Maybe the point of a Bitcoin futures exchange is to allow fun but not-too-serious gambling on Bitcoin. Having 20x leverage and socialized clawbacks is, in a certain light, a way to reduce volatility, as experienced by your customers. If Bitcoin prices drop by more than 5 percent, then the people who were long only lose 5 percent, while the people who were short theoretically make more than 5 percent, but have to give up a chunk of it in “clawbacks.” Both wins and losses are trimmed a bit. It’s a way to bet on Bitcoin but not exactly mean it.

Elsewhere, “Korean Authorities Investigate Alleged Crypto Scam That Promised Investors Shipwreck Gold,” why not. When I read about financial scams I often think about the “Linda problem,” in which people hear a description of a woman named Linda (“single, outspoken and very bright”) and are asked if it is more probable that “Linda is a bank teller” or that “Linda is a bank teller and is active in the feminist movement.” The former is strictly more probable, but people tend to choose the latter, because it has a story, a personality, a coherence; they are swayed not by bare facts and rational analysis but by wanting to create a vivid picture of who Linda is. Similarly, is it more likely that if you give someone money they will pay you back with gold from a Russian shipwreck, or that if you give someone money they will pay you back in gold from a Russian shipwreck and also somehow with crypto? If you’re into shipwrecks, and you’re into crypto, and you’re into getting your money stolen, then combining all three is somehow extra satisfying.

Disclosure.

There is a popular belief that being a professional investor and trying to find out information about companies is, somehow, cheating. Like if you are a hedge-fund manager and you do lots of research and pay for proprietary data sources and go to private one-on-one meetings with corporate executives, then you have advantages that regular retail investors don’t have. There is no level playing field for the retail investors. It’s unfair.

But there is a contrary belief that is less popular but more entertaining, which is that actually the retail investors are cheating. After all, any random hobbyist can read a public company’s annual report and find out lots of detailed information about the company’s finances and strategy. And she didn’t need to put in any work to get that report; it was just made freely available to her online by Securities and Exchange Commission disclosure rules. By making all this good stuff available to just anyone off the street, those rules unfairly reduce the value of professional investors’ skills and hard work. This makes high-skill professional investing less rewarding than it would otherwise be, reducing the differences in results between good and bad investors. And that reduces the incentives to become a good investor, which makes markets less efficient.

I mean, you don’t frequently see quite it expressed quite that way, but you can get pretty close. Here is “Is Silence Golden? Negative Effects of Mandatory Disclosure,” by Sudarshan Jayaraman and Joanna Wu of the University of Rochester:

Disclosure regulation is a cornerstone of modern securities markets. Its economic consequences have been extensively studied and heavily debated. A widely recognized benefit of mandatory disclosure is that it levels the playing field by publicly disclosing to everyone what is known only to sophisticated investors. This leveling reduces trading costs and consequently reduces the firm’s cost of capital.

In our recent paper, available here, we show that this reduced informational advantage of sophisticated investors is not unambiguously desirable. In particular, when sophisticated investors stop trading in a firm’s stock, there is a reduction in the ability of firm managers to glean decision-relevant information from the stock price. In other words, mandatory disclosure impedes the feedback effect of stock prices on managerial decisions, which in turn could harm investment efficiency. In documenting such an effect, we demonstrate that the economic consequences of mandatory disclosure are broader than often thought and, under certain conditions, mandatory disclosure can crowd out informed traders’ ability to acquire information, resulting in less managerial learning from the stock price. This in turn lowers the efficiency of the manager’s investment decisions.

Things happen.

MoviePass still exists. “Take money from venture capitalists, provide a below-market price for a popular service, and profit.” Wall Street Claims Success on Diversity— At Least With Interns. Uber Is Not Serious About Changing Its Toxic Culture. For Tesla’s Elon Musk, Twitter Is Sword Against Short Sellers. An inside look at how Trump’s infamous jobs day tweet roiled some government economists. Jeff Bezos, Style Icon. 6 Faces That Honestly I've Never Seen Leonardo DiCaprio Make Before. “What if the entire Earth was instantaneously replaced with an equal volume of closely packed, but uncompressed blueberries?”

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matt Levine is a Bloomberg Opinion columnist covering finance. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz, and a clerk for the U.S. Court of Appeals for the 3rd Circuit.

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